Are bottlenecks threatening Switzerland’s recovery?

Authors: Florian Germanier, Economist, UBS Switzerland AG; Alessandro Bee, Economist, UBS Switzerland AG

Starting point

In the wake of the COVID-19 crisis, global industrial output collapsed in the spring of 2020. In addition to a sharp decline in demand, supply-related factors were also responsible for the slump. In order to contain the pandemic, production facilities were closed and international traffic was greatly reduced. This led to production losses and interruptions in global value chains.

Recovery brings supply bottlenecks

From the second half of 2020 onwards, the industrial production recovered strongly. Thanks to ongoing vaccination programs, it already exceeded the pre-crisis level in many countries in 1H21. However, delays in the supply chains did not ease, rather they increased. In Switzerland, according to a Swiss National Bank (SNB) report, around two-thirds of companies surveyed expressed delivery difficulties in 2Q21. By way of comparison, at the height of the crisis in 2Q20, only a third of companies faced difficulties in procurement.

The monthly survey of Swiss purchasing managers (PMI) paints a similar picture. The interruption of global value chains in spring 2020 was reflected in an increase in delivery times (grey line, Fig. 1). With the end of the first wave of the pandemic and global shutdowns, the situation eased in the summer of 2020 before delivery times rose rapidly again in the wake of the global recovery. In addition, the difficult procurement situation was also reflected in sharply rising purchase prices. Recently, around 90% of companies recorded an increase in purchase prices (black line).

This report has been prepared by UBS Switzerland AG. Please see important disclaimers and disclosures at the end of the article.

The price increase in primary products is mainly driven by raw material prices. Producer prices for coal and crude oil rose by more than 50% y/y in August, for metal products and wood, the price increase was between 10% and 20%, and for rubber and plastic goods about 6%.

What are the risks?

According to the SNB, the difficult procurement situation, together with the pandemic, is determining companies' risk outlook. The longer delivery times and the increase in purchase prices can also have a negative impact on the economy as a whole, albeit in different ways.

? Bottlenecks: Increased delivery times are fueling concerns that production bottlenecks could jeopardize the economic recovery. Such a scenario is conceivable if important suppliers fail, leading to production stops along the value chains. In response to the production losses, companies would have to reduce their staff, which would put a strain on household income. As a result of the reduced consumption, a majority of the industries would be negatively affected, thus severely curtailing economic growth.

? Inflation: Sharply rising purchase prices can force central banks to react and thus slow economic growth sharply, as the two oil crises of the 1970s showed. At the time, a rapid rise in the price of oil led to an upward spiral in inflation and forced central banks to tighten their monetary policy. The result was stagflation, i.e. a stagnating economy coupled with high inflation.

What are the causes?

In order to assess the consequences of the bottlenecks on the economy, it is important to distinguish whether the difficult procurement situation is due to demand or supply factors.

? If the bottlenecks are due to strong demand, production is likely to be postponed to later quarters, but not to strangle the economic recovery. The companies are well utilized, but cannot increase their production further due to capacity restrictions.

? The situation is different when the bottlenecks come from the supply side. Companies can and want to produce more, but are held back because suppliers cannot deliver or have disappeared altogether. If the output shortfall is temporary and only affects individual product categories, the negative effect is unlikely to persist and will not be transferred to other industries. However, if the loss of production turns out to be permanent or comprehensive, the economy is in danger.

Bottlenecks are also supply-driven

An indication of whether the current bottlenecks are perceived by companies as demand- or supply-induced is provided by the survey of purchasing managers (see Fig. 1). Generally, delivery times and purchase prices correlate with incoming orders. In the past, strong demand for goods was the most important driver of delays in delivery times, including in the aftermath of the global financial crisis. As the upswing began and order books filled up, purchase prices rose and delivery times increased.

Recently, the situation in terms of delivery times and purchase prices has worsened, while the order backlog has stopped improving — an indication that supply-related factors play a much greater role in the current recovery than ten years ago. Production capacities were reduced during the pandemic due to a lack of demand and can now only be gradually adjusted to the rebounding demand. In addition, restrictions in certain areas of world trade continue to weigh on value chains, such as the far-reaching lockdowns in China amid new coronavirus cases.

What's next?

Production potential remains intact

A permanent decoupling of order intake from delivery delays, which would indicate a longer-term reduction in production potential, seems unlikely to us. In industrialized countries, thanks to the generous fiscal policy support, waves of insolvency were avoided and especially in Europe, many companies were able to “maintain” their workforce thanks to furlough schemes. The production potential is likely to stay intact in the long term. This supports our view that value chains will eventually return to normal and that delivery delays will subside.

Demand normalizes, supply increases

In the short term, the global economy should continue to benefit from the ongoing reopening and continue its recovery, supporting demand for goods. However, economic growth is likely to have peaked in recent months, so excess demand is declining.

At the same time, supply is likely to increase in the coming quarters and production shortfalls will become less frequent. An indication of an increase in supply is provided by the container throughput index, which correlates with industrial production (see Fig. 2). The index recorded a strong revival in international container trade in August, mainly thanks to a strong increase in China. Bottlenecks are unlikely to ease in the coming months. But rising supply and declining demand point to a de-escalation of the procurement situation over the course of next year.

Rise in inflation only temporary

On the inflation side, the shortages mean an increase this year, but probably not next year. So far, there is no evidence that the higher product prices are spilling over into service prices. In addition, the rise in inflation is mainly being driven by higher oil prices. In Switzerland, petroleum products accounted for roughly 0.6 percentage points of the 0.9% y/y increase in consumer prices in September.

We expect oil prices to remain stable in the coming quarters as the market should be balanced in 2022 as supply increases. And we also expect stable prices in the long term for the other raw materials we cover as demand and supply are likely to level out. This also means that inflation in both import and producer prices is likely to stabilize next year. In the case of electricity prices, this is subject to winter in Europe not being too cold.

Bottlenecks can postpone recovery

We expect the bottlenecks to be resolved and prices to normalize. However, there is great uncertainty regarding the timing of the improvement. On the one hand, it is unclear how and when the strong demand for goods will normalize. On the other hand, it is difficult to predict when and how much supply will increase. In addition, local virus outbreaks can lead to production downtimes and exacerbate bottlenecks. However, as these are only temporary outages, the effect on the economy is unlikely to persist. Bottlenecks are therefore likely to lead to a postponement of economic growth, but not to stifle the recovery.

Furthermore, risk of persistently high inflation is manageable. The inflationary effect of high commodity prices is likely to ease gradually. Before the crisis, deflationary forces had the upper hand in Switzerland, and the crisis itself weighed on the labor market and led to underutilization of the economy. For “commodity inflation” to become broad-based inflation, inflation would have to spread to domestic prices, and in particular to service prices. Although these have recently increased somewhat, the rise has been mild and the experience of the last decade speaks against a strong and sustained increase in service inflation (see Fig. 3). This also leaves the risk of stagflation low.

Less risk in Switzerland

Furthermore, the risk of stagflation in Switzerland is likely to be even less pronounced than globally. This is because the safe-haven characteristic of the Swiss franc will likely lead to disinflationary pressure, in a downturn scenario. In addition, the increase in producer prices is less pronounced than, for example, in the US or the Eurozone, which dampens the risk of inflation in Switzerland versus other countries (see Fig. 4).

The data on domestic inflation, the PMI surveys and the statistics on global trade will likely shed light on the procurement situation in the coming months. Even if stagflationary tendencies are unlikely, it is important to keep an eye on the risk.

Appendix

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